The Threat to Ireland’s Economic Recovery

Our Irish correspondent Maurice Fitzpatrick looks at the current challenges facing the Emerald Isle’s economy.

Morgan Kelly belongs to that very rare breed of Irish economic analyst to have emerged in the public eye since the crash who does not seek to hog the media limelight; indeed he positively shuns celebrity status, which partly explains the near three year lag since he last entered the fray—he has not written about the Irish economy since May 7^th, 2011. Kelly’s forecasts had become increasingly resonant from the late noughties onwards, in proportion to his proven ability to consistently call the game correctly.

Back in 2011, he predicted national ruin if Irish finances were permitted to run their natural course. In other words, if the collection of mortgage and business loans was enforced with any rigour, mass default would be the only option open to a great number of people in debt, and the entire economy would tank. Shivers spread across Ireland’s four provinces when Kelly wrote of ruin and its political consequences.

Kelly has just broken his silence by delivering a public lecture on March 4^th, and this time his subject was Mario Draghi. Draghi, who succeeded Jean-Claude Trichet as President of the European Central Bank in November 2011, set himself the task of doing ‘whatever it takes’ to save the euro. Over two years on, the ECB seems to have picked the right man at the right time. Nobel-prize winning economist Paul Krugman, lecturing also at UCD this February, heaped praise on Draghi for managing to steer a path past European austerians to enable growth. With his focus on enabling investment flow to the periphery, Draghi has heralded, in the words of Krugman, an ‘institutional culture at the ECB [that] is now substantially more open-minded’; and that is ‘a good thing for Europe’.

While Kelly acknowledged that Draghi and his ECB colleagues have indeed gone easy on Irish debtors, he also warned that without such leniency a swathe of small and medium-sized enterprises (SMEs) could not survive. Therein lies a problem. We know too little about the SMEs’ ledgers to make a proper estimate of how many of them are genuinely sustainable, but undoubtedly a great many are burdened with large property portfolios and would not survive stern pressure to repay their debts. Given that seven out of ten Irish employees depend on SMEs for their livelihood makes this matter very serious. What happens if the ECB ceases to be understanding and starts to call in its debt?

When such a question is posed in Ireland, a standard reflex of our politicians is to insist that that could never happen. Yet this time, perhaps because of Kelly’s past record, our Minister for Finance, Michael Noonan, immediately responded to Kelly’s comments. Noonan suggested that the Central Bank of Ireland should welcome consultation with Kelly and stated that Kelly’s arguments will be taken seriously: ‘I still would like to examine Morgan Kelly’s views in detail, and maybe if the Central Bank, who have the primary responsibility here, would contact him [to] have a conversation about his concerns, that might be helpful’.

But the Central Bank will hesitate to contact Kelly. The suggestion that it should reach out to him will have rankled the Central Bank’s governor, Patrick Honohan, who was the butt of a rather personal philippic of Kelly’s in 2011.

What can we make of all of this? It is certain that Noonan does not, like his predecessor, wish to ruffle feathers in the eurozone’s core; but, surely, neither does he wish to be undermined by his central bank governor in the manner in which his predecessor was at a crucial moment in deciding the future of Irish finance. Creating a major role for Kelly in the Central Bank would suddenly throw fat in the fire from Europe’s point of view—they are not used to Irish negotiators being tough and realistic—but it would a good appointment for Ireland, and for Europe in the long-term too.

Kelly’s preference for a low-key profile has ironically heightened his attraction to the people who control the levers of power, insofar as there is any real governmental power, in Ireland. And Kelly has emerged once again as evidently the best brain to negotiate our position in Europe. He is aware that Irish banks need to grasp a stinging nettle—the volume of people and businesses that are effectively insolvent because of their boom time loans—sooner or later. When the Irish banks do that will depend on the European Central Bank, which so far has blithely let Irish debt flutter in the wind. Under what other circumstances would almost 20% of a country’s mortgages be underwater and an untold amount of SME debt go unpaid without the imposition of a resolution? As Kelly put it, the ECB keeps ‘pumping sweet, sweet credit into our veins and we haven’t had the real crisis yet’. But that could change at any minute and, as Kelly suggested, more powerful European countries may opt to use Ireland as a guinea pig to witness what happens to a peripheral country when the current of credit is switched off.

Draghi is not stupid and plotting to bring disaster to any eurozone country (above all one that was held up as exemplary, a people who took pain which was the making of them) would be a bad move for him too. So in what scenario, if any, would he allow that to happen? Embarrassing as it is to admit, Ireland’s economic survival depends on the forbearance of Central European bankers since we cannot survive without the artificial financial floor provided for us. Draghi needs to sell continuous leniency and, ultimately, a significant measure of debt forgiveness to his ECB colleagues and backers who do not all, by any means, agree with that approach to managing the eurozone. Kelly’s iceberg on the horizon is a very real one and a definite swerve to avoid it is required at the European level for us to pull through. Until that happens, Ireland remains trapped in the endgame.

Maurice Fitzpatrick, March 2014